Tax breaks could ease pain of JPMorgan deal

JPMorgan Chase has struck a tentative deal with the Justice Department to pay a record $13 billion over dodgy mortgage products — but the biggest U.S. bank may be able to slash that bill by paying Uncle Sam less in taxes.

Details of the pact are now being finalized, but it is expected to include $9 billion paid to the government and $4 billion in relief for wronged customers.

Section 162(f) of the tax code bars deductions for fines and penalties paid to the government, but JPMorgan might be able to negotiate an agreement to classify the payments as something else. Those payments labeled compensatory or for restitution are more likely to be deductible.

“These are big numbers,” said Alan Feld, a law professor at Boston University. “I’m not sure that I as a taxpayer am so happy about helping JPMorgan to pay.”

The settlement documents may or may not talk about the taxes, but they will characterize the payments.

“Sophisticated counsel have this in mind” when they are negotiating, said Feld, who added it’s possible the deal could be structured so the bank might legally deduct nearly all of the payments.

How certain payments are described in the final deal very well may have been a factor in getting JPMorgan to agree to the $13 billion figure, some tax lawyers and other experts said.

“There might be a reason for the government to negotiate an agreement which assures the deductibility of [certain] payments by JPMorgan Chase,” said George Yin, a law professor at the University of Virginia and former chief of staff at the congressional Joint Committee on Taxation. “In that case, [JPMorgan] might be willing to agree to a larger gross settlement amount, which might play well for the government.”

The Justice Department and JPMorgan did not respond to a request for comment.

As part of the tentative $13 billion deal, JPMorgan will pay $4 billion to the Federal Housing Finance Agency over mortgage-backed bonds the bank sold to taxpayer-owned Fannie Mae and Freddie Mac in the lead-up to the financial crisis, according to a source.

The FHFA sued JPMorgan and 17 other banks in 2011, alleging that the underlying loans in more than $200 billion worth of mortgage bonds sold to Fannie and Freddie were riskier than disclosed. The agency’s suit against JPMorgan covered roughly $33 billion in bonds sold between 2005 and 2007.

Steve Rosenthal, a former corporate lawyer and fellow at the Tax Policy Center, said the payments to FHFA might be interpreted either way: as penalties or as restitution.

“I am guessing it is probably described in a way that allows JPMorgan to deduct,” said Rosenthal, a former legislative counsel at the Joint Committee on Taxation.

He also said if some amount of money is set aside for institutional investors, that could be deductible as well because JPMorgan would have included that as income that they are now returning, making the ledgers balanced.

Tax deductions taken for corporate wrongdoing caused a stir when ExxonMobil struck a $1.1 billion deal to settle charges for the Valdez oil spill and wound up with an after-tax cost of about half that amount, Rosenthal said.

Lawmakers growled and proposals to limit deductions, in particular for punitive damages, have been debated ever since. Punitive damages are still deductible.

Later, senators led by Chuck Grassley (R-Iowa) protested when they found out Boeing could deduct a $615 million settlement with the government over ethics charges. Under pressure from lawmakers, Boeing said it would take no tax deductions at all for the pact.

President Barack Obama proposed barring deductions for punitive damages as part of his fiscal year 2014 budget. “The deductibility of punitive damage payments undermines the role of such damages in discouraging and penalizing certain undesirable actions,” the administration said. Eliminating the tax break would raise an estimated $372 million over a decade, according to the budget.